A Treatise on Political Economy

Jean-Baptiste Say
Say, Jean-Baptiste
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C. R. Prinsep, trans. and Clement C. Biddle., ed.
First Pub. Date
Philadelphia: Lippincott, Grambo & Co.,
Pub. Date
6th edition. Based on the 4th-5th editions.
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Of Bills of Exchange and Letters of Credit.


A bill of exchange, a promissory note or check, and a letter of credit, are written obligations to pay, or cause to be paid, a sum of money, either at a future time, or at a different place.


The right conveyed by the assignment of these engagements, though not capable of being enforced immediately, or elsewhere than at the stipulated place, yet gives them an actual value, greater or less, according to circumstances. Thus a bill of exchange for 100 dollars, payable at Paris at two months' date, may be negotiated or sold, at pleasure, at the rate of, say 99 dollars, while a letter of credit of like amount, payable at Marseilles in the same space of time, will, perhaps, be worth at Paris but 98 dollars.


These engagements may be used as money in all transactions of purchase, as soon as they are invested with actual present value, by the prospect of their future value; indeed, most of the greater operations of commerce are effected through the medium of these securities.


Sometimes, the circumstance of a bill of exchange being payable at another place will increase, instead of diminishing its value; but this depends upon the state of commerce for the time being. If the merchants of Paris have large payments to make to those of London, they will readily give more money at Paris for a bill upon London, than it will produce to the holder at the latter place. Thus, although the pound sterling contain precisely as much silver as 24 fr. 74 cents, they will, perhaps, give at Paris 25 fr., more or less, for every pound sterling payable in London.*86


This is what is called the course of exchange, being, in fact, a mere specification of the quantity of precious metal people will consent to give, for the transfer of a right to receive a given quantity of the same metal at any other specified place. The particular locality of the metal reduces or increases its value, in relation to the same metal situated elsewhere.


The exchange is said to be in favour of any country, France, for example, whenever less of the precious metal is there given for, than will be produced by, a bill of exchange upon another country; or whenever in the foreign country more of the precious metal is given for a bill of exchange on France, than it will there produce to the holder. The difference is never very considerable, and cannot exceed the charge of transporting the precious metal itself; for, if a foreigner, who wants to make a payment at Paris, can remit the sum in specie at less expense than he could be put to by the existing course of exchange, he would undoubtedly remit in specie.*87


It has been imagined by some people, that all debts to foreigners can be paid by bills of exchange; and measures have been frequently suggested, and sometimes adopted, for the encouragement of this fictitious mode of payment. But this is a mere delusion. A bill of exchange has no intrinsic value; it can only be drawn upon any place for a sum actually due at that place; and no sum can be there actually due, unless an equal value, in some shape or other, has been remitted thither: the imports of a nation can only be paid by the national export; and vice versâ. Bills of exchange are a mere representative of sums due; in other words, the merchants of one country can draw bills on those of another for no more, than the full amount of the goods of every description, silver and gold included, which they may have sent thither directly or indirectly. If one country, say France, have remitted to another country, Germany perhaps, merchandise to the value of 2 millions of dollars, and the latter have remitted to the former to the amount of 3 millions of dollars, France can pay as much as 2 millions by the means of bills of exchange, representing the value of her export; but the remaining 1 million cannot be so discharged directly, although possibly they may by bills of exchange upon a third country, Italy, for instance, whither she may have exported goods to that extent.


There is, indeed, a species of bills, called by commercial men, accommodation-paper, which actually represents no value whatever. A merchant at Paris, in league with another of Hamburgh, draws bills upon his correspondent, which the latter pays or provides for, by re-drawing and negotiating or selling bills at Hamburgh upon his correspondent at Paris. So long as these bills are in possession of any third person, that third person has advanced their value. The negotiation of such accommodation-paper is an expedient for borrowing, and a very expensive one; for it entails the loss of the banker's commission, brokerage and other incidental charges, over and above the discount for the time the bills have to run. Paper of this description can never wipe out the debt, that one nation owes another; for the bills drawn on one side balance and extinguish those on the other. The Hamburgh bills will naturally counterpoise those of Paris, being in fact drawn to meet them; the second set destroys the first, and the result is absolute nullity.


Thus it is evident, that one nation cannot otherwise discharge its debts to another, than by remittance of actual value in goods or commodities, in which term I comprise the precious metals, amongst others, to the full amount of what it has received or owes. If the actual values directly remitted thither are insufficient to balance the receipts or imports thence, it may remit to a third nation, and thence transport produce enough to make up the deficit. How does France pay Russia for the hemp and timber for ship-building imported thence? By remittance of wines, brandies, silks, not merely to Russia, but, likewise to Hamburgh and Amsterdam, whence again a remittance of colonial and other commercial produce is forwarded to Russia.


Governments have commonly made it their object to contrive that the precious metals shall form the largest possible portion of the national import from, and the least possible portion of the national export to, foreign countries. I have already taken occasion to remark, with regard to what is improperly called the balance of trade, that, if the national merchant finds the precious metals a more profitable foreign remittance than another commodity, it is likewise the interest of the state to remit in that form; for the state can only gain and lose in the persons of its individual subjects; and, in the matter of foreign commerce, whatever is best for the individuals in the aggregate, is best for the state also.*88 Thus, when impediments are thrown in the way of the export of the precious metals by individuals, the effect is to compel an export in some other shape, less advantageous to the individual and the public too.

Of Banks of Deposit.


The constant intercourse between a small state and its neighbours occasions a perpetual influx of foreign coin. For, although the small state may have a national coinage of its own, yet, the frequent necessity of taking the foreign instead of the national coin in payment, requires the fixation of the ratio of their relative value, in the current transactions of business.


There are many mischiefs attending the use of foreign coin, arising chiefly from the great variation of weight and quality. It is often extremely old, worn, and defaced; not having participated in the general re-coinage of the nation that issued it, where, perhaps, it is no longer current; all which circumstances, though considered in settling its current relative value to the local coin, yet, do not quite reduce it to the natural level of depreciation.


Bills drawn from abroad upon such a state, being payable in the coin thus rendered current, are, in consequence, negotiated abroad at some loss; and those drawn upon foreign countries, and, consequently, payable in coin of a more steady and intelligible value, are negotiated in a smaller state at a premium, because the holder of them must have purchased them in a depreciated currency. In short, the foreign coin is always exchanged for the local currency to a loss.


The remedy devised by states of this inferior class is the subject of the present section. They established banks,*89 where private merchants could lodge any amount of local national coin, of bullion, or of foreign coin, reckoned by the bank as bullion; and the amount, so lodged, was entered as so much money of the legal national standard of weight and quality. At the same time, the bank opened an account with each merchant making such deposit, giving him credit for the amount of the deposit. Whenever a merchant wanted to make a payment, there was no occasion to touch the deposit at all; it was sufficient to transfer the sum required, from the credit of the party paying, to that of the party receiving. Thus values could be transferred continually by a mere transfer in the books of the bank. The whole operation was conducted without any actual transfer of specie; the original deposit, which was entered at the real intrinsic value at the time of making it, remained as security for the credit transferred from one person to another; and the specie, so lodged with the bank, was exempt from any reduction of value by wear, fraud, or even legislative enactment.


The money still remaining in circulation, wherever it was exchanged for the bank deposits, that is to say, for entries in the bank books, necessarily lost in proportion to the reduction of its intrinsic value. And this loss occasioned the difference of value, or agio at Amsterdam, between bank money and circulating money, which was on the average from 3 to 4 per cent. in favour of the former.


It will easily be imagined, that the bills of exchange, payable in a currency so little liable to injury or fluctuation, must be negotiable on better than ordinary terms. In fact, it was observable, that on the whole, the course of exchange was rather in favour of the countries that paid in bank, and unfavourable to those that paid in circulating money only.


The bank retained the deposities in perpetuity; for the re-issue would have been attended with serious loss; inasmuch as it would have been the same thing, as producing good money of the full original value, to be taken at par with the deteriorated circulating coin, which passes current for—not its intrinsic, but its average weight. The coin withdrawn from the bank would have been mixed up with the mass of circulation, and passed current at par with the rest. So that the withdrawing such deposits would have been a gratuitous sacrifice of the excess of value of bank above circulating money.


This is the nature of banks of deposit; most of which combined other operations with the primary object of their institution; but of them I shall speak elsewhere. They derived their profits, partly from a duty levied upon every transfer, and partly from operations incident to, and compatible with, their institution; as, for example, advances made upon a deposit of bullion.


It is evident, that the inviolability of the deposit, confided to them, is essential to the success of such establishments. At Amsterdam, the four burgomasters, or municipal magistrates, were trustees for the creditors. Annually, on leaving office, they handed over the trust to their successors, who, after inspecting the account, and verifying it by the registers of the bank, bound themselves by oath, to surrender their charge inviolate to their successors in office. This trust was scrupulously executed from the first establishment of the bank in 1609 until 1672, when the forces of Louis XIV. penetrated as far as Utrecht. The deposits were then faithfully restored to the individuals. It would seem to have been afterwards less scrupulously managed; for, when the French took possession of that capital, in 1794, and called for a statement of the concern, it was found to be in advance of no less a sum than 10,624,793 florins to the India company, and to the provinces of Holland and West-Friezeland, which were wholly unable to repay it. In a country governed by a power without control or responsibility, it may be expected, that such a deposit would have been still more exposed to violation.*90

Of Banks of Circulation or Discount, and of Bank-notes, or Convertible Paper.


There is another kind of bank, founded on totally different principles; consisting of associated capitalists, subscribing a capital in transferable shares, to be employed in various profitable ways, but chiefly in the discount of promissory notes and bills of exchange, that is to say, the advance of the value of commercial paper not yet due, with the deduction of interest for the time it has to run, which is called, the discount.


These companies, with a view to enlarge their capital and extend their business, commonly issue notes, purporting to bear a promise to pay to the bearer on demand, the gold or silver specified on the face of them. Their security for the due discharge of these engagements is, the commercial paper held by the bank, and subscribed by individuals in solvent circumstances; for the company gives its notes in discount, or, what is the same thing, in purchase of this paper.


The private commercial paper, indeed, having a term to run before it falls due, can not be available in discharge of notes payable on demand; for which reason, every well-conducted bank of circulation confines its advances of cash, or notes payable in cash on demand, to the discount of bills at very short dates, and is careful to have always in hand a considerable amount of specie, probably a third, or as much as the half of the total amount of their circulating notes; and, even with all possible caution, it is at times greatly embarrassed, whenever a want of confidence in its solvency, or any untoward event, causes a sudden run upon the bank for cash. The bank of England has been obliged, on an occasion of this kind, to scrape together as many sixpences as it possibly could find, to gain time by the delay inseparable from payments in such a diminutive coin, until a part of the paper in its possession had fallen due. The discount bank of Paris, in the year 1788, being then under control of government, had recourse to similar paltry expedients.


The profits of banks of circulation are very considerable; that portion of the notes, which is issued on the credit of private commercial paper, continues running at interest; for the advances have been made with the deduction of the discount. But the portion of the paper, issued on the credit of the specie in reserve, brings no profit; the interest lying dormant in the specie thus withdrawn from circulation.


The banks of England and France make no advances to private persons, except on bills of exchange, and give no credit beyond the funds in hand. They indemnify themselves for the trouble of receiving and paying on account of individuals by turning to account the floating balance left in their hands. These two establishments have, besides, undertaken the business of paying the interest upon the respective national debts, receiving an allowance for their trouble: furthermore, they occasionally make advances to the governments.


From these various operations, they derive a great increase of their profits. The one last mentioned, however, is completely at variance with the purposes of their establishment, as we shall presently find. The advances made to the old government of France by the then bank of discount, and those of the bank of England to the English government, compelled those bodies to apply to the respective legislatures to give their notes a compulsory circulation; thus destroying their fundamental requisites of convertibility. The consequence has been, that the former of these banks went all to pieces.


The establishment of several banks, for the issue of convertible notes, is more beneficial than the investment of any single body with the exclusive privilege; for the competition obliges each of them to court the public favour, by a rivalship of accommodation and solidity.


Banks of circulation issue their notes either in the discount of promissory notes or bills of exchange, that is to say, in giving their notes payable on demand, and circulating like cash, in exchange for private paper payable at a future date, upon which interest is deducted; which is the course pursued by the present bank of France, and by all the English banks, public and private; or else in lending at interest to solvent individuals, like those of Scotland. Merchants of good credit are, in the latter way, supplied with the sums necessary for their current expenses and payments, and each of them is thereby enabled to embark his whole capital in his commercial enterprises, without being obliged to reserve any part to meet the calls upon him in the course of business. The merchant of Paris or London must contrive matters, so as to have always on hand either in his private coffers or in the bank, a sum sufficient to face the demands upon him; whereas, the merchant of Edinburgh is relieved from this necessity, and at liberty to invest the whole of his funds, in the confidence that the bank will advance him the money he may happen to require.*91


A bank of circulation affords the advantage of economizing capital, by reducing the amount of the sum, kept in reserve for the current and contingent expenses of the individuals it accommodates.


Bank bills or notes, payable on demand, and circulating as cash, play so important a part in the progress of national wealth, and have engendered such important errors in the brain of many writers of repute and information on other topics, that it will be worth while to examine their nature and consequences in a very particular manner.


I should premise, that the residue of this section applies exclusively to bank-notes, depending solely upon the credit of the bank for their currency, and convertible at pleasure into cash or specie.


It is a matter of no less curiosity than of importance, to inquire whether bank-notes, or paper destitute of intrinsic value, be any addition to the stock of national wealth, and what, if any, is the possible extent of that addition; for, were there no limits to it, there could be no end to the wealth, that a state might acquire in a short time by the mere fabrication of some reams of paper. The solution of this grand problem may be set down as one of Smith's happiest efforts; yet it is not every body that comprehends his reasoning; I will try to render it more generally intelligible.


The wants of a nation require a certain supply of such particular commodity, and the extent of that supply is determined by the relative prosperity of the nation for the time being. A surplus of each of those commodities beyond this demand is either not produced at all, or, if produced, must occasion a decline of relative local value: it, therefore, naturally finds its way out of the country, and goes in quest of a market, where it may be in higher estimation.


Money is, in this respect, like all other commodities; it is a convenient agent, and, therefore, employed as such in all operations of exchange; but the intensity of the demand for it is determined in each community, by the relative extent and activity of the exchanges negotiated within it. As soon as there is a supply of money sufficient to circulate all the commodities there are to be circulated, no more money is imported; or, if a surplus flow in, it emigrates again in quest of a market, where its value is greater, or where its utility is more desired. It is seldom or never that any body keeps in his purse or his coffers more specie than enough to meet the current demands of his business or consumption.*92 Every excess beyond these demands is rejected, as bearing neither utility nor interest; and the community at large is fully supplied with specie, as soon as each individual is possessed of the portion suitable to his condition and relative station in society.


It may be safely left to private interest, to make the best use of the excess of specie beyond the demand for circulation. The notion that every item of specie, that crosses the frontier, is so much dead loss to the community, is just as absurd as the supposition, that a manufacturer is so much the poorer, every time he parts with his money in the purchase of the ingredient or raw material of his manufacture; or that individuals, the aggregate of whom makes up the nation, present foreigners gratuitously with all the money they part with.


Taking it for granted, then, that the specie, remaining in circulation within the community, is limited by the national demand for circulating medium; if any expedient can be devised, for substituting bank-notes in place of half the specie or the commodity, money, there will evidently be a superabundance of metal-money, and that superabundance must be followed by a diminution of its relative value. But, as such diminution in one place by no means implies a contemporaneous diminution in other places, where the expedient of bank-notes is not resorted to, and where, consequently, no such superabundance of the commodity, money, exists, money naturally resorts thither, and is attracted to the spot where it bears the highest relative value, or is exchangeable for the largest quantity of other goods: in other words, it flows to the markets where commodities are the cheapest, and is replaced by goods, of value equal to the money exported.


The money that can emigrate in this manner, is that part only of the circulating medium, which has a value elsewhere than within the limits of the nation; that is to say, the specie or metal-money. Since, however, specie does not emigrate without an equivalent return; and, since its value, which before existed in the shape of specie, and was exclusively engaged in facilitating circulation, thenceforth assumes the form of a variety of commodities, all items of the reproductive national capital, there follows this remarkable consequence, that the national capital is enlarged to the full amount of all the specie exported upon the introduction of the substitute. Nor is the internal national circulation at all cramped for want of money by this export; for the functions of the specie, that has been withdrawn, are just as well performed by the paper substituted in its stead.


However valuable an acquisition the national capital may thus receive, it must not be rated above its real amount. I have supposed, for the sake of simplicity, that half the specie might be replaced by circulating notes: but this is a monstrous proportion; particularly if it be considered, that paper cannot retain its value as money any longer than while it is readily and instantly convertible into specie; I say, readily and instantly, because otherwise people would prefer specie, which is at all times, and without the least hesitation, taken for money. To insure this requisite convertibility, it is necessary, that, besides having at all times a fund in reserve, in private bills or securities, or in specie, sufficient to meet all the notes that may be presented, the bank itself should be at all times within the reach of the holders of its notes. Therefore, if the territory be of any extent, and the notes so generally circulated, as to form half of the circulating medium, the subordinate offices of the bank must be greatly multiplied to place them within reach of all the note-holders.


But, granting the possibility of such an arrangement, and admitting, that paper might supplant as much as half the requisite national currency of specie, let us see what would be the amount of the acquisition to the national capital.


No writer of repute has ventured to estimate the requisite circulating specie of any nation, higher than 1/5 of the annual national product; some, indeed, have reckoned it as low as 1/30. Taking the highest estimate, viz. 1/5 of the annual product, which, for my own part, I consider greatly above the reality in any case; a nation, whose annual product should amount to 20 millions, would need but 4 millions of specie. Therefore, in case the half, or 2 millions, were supplanted by circulating paper, and employed in augmenting the national productive capital, that capital would be once for all augmented, by a value equal to 2/20 or 1/10 of the annual product of the nation.


Again, the annual product of a nation would, probably, be much overrated at 1/10 of the gross national productive capital; but let it be set down at that rate, allowing 5 per cent. interest on productive capital, and 5 per cent. wages and profits of the industry it sets in motion. On this calculation, supposing the paper substitute to add to the national capital, in the ratio of 1/10 of its annual product, this addition will not at the highest estimate exceed 1/100 of the previous capital.


Although the practicable issue of bank-notes procures to a nation of moderate wealth an accession of capital, much less considerable than people may fondly imagine, this accession is, notwithstanding, of very great value; for, unless the productive energy of the nation be extremely great, as in Great Britain, or the national spirit of frugality very general and persevering, as in Holland, the annual savings withdrawn from unproductive consumption, to be added to productive capital, form, even in thriving states, a very inconsiderable portion of the gross annual revenue. Nations, whose production is stationary, as every body knows, make no addition to their productive capitals; and the consumption of those on the decline annually encroaches on their capitals.


Should the paper-issues of a bank at any time exceed the demands of circulation, and the credit enjoyed by the establishment, there follows a perpetual reflux of its notes, and it is put to the expense of collecting specie, which is absorbed as fast as collected. The Scotch banks, though productive of great benefit, have been obliged, upon such trying occasions, to keep agents in London constantly employed, in scraping specie together at a charge of two per cent., which specie was instantly absorbed. The bank of England, in similar circumstances, was under the necessity of buying gold bullion, and getting it coined; and this coin was melted again as fast as it was paid by the bank, in consequence of the high price of the metal, which was itself the effect of the constant purchases made by the bank, to meet the calls upon it for specie. In this manner, it sustained the annual loss of from 2 ½ to 3 per cent., upon a sum of about 850,000l.,*93 more than 20 millions of our money. I say nothing of the situation of this bank of late years, since its notes have acquired a forced circulation, and, consequently, altered their nature entirely.


The notes issued by a bank of circulation, even if it have no funds of its own, are never issued gratuitously; and, therefore, of course, imply the existence, in the coffers of the bank, of a value of like amount, either in the shape of specie, or of securities, bearing interest; upon which latter only the whole real advance of the bank is made; and this advance can never be made upon securities that have a long time to run; for the securities are the fund, that is to provide for the discharge of another class of securities, in the hands of the public at large, payable at the shortest of all possible notice, namely, on demand. Strictly speaking, a bank can not be at all times in a condition to face the calls upon it, and deserve the entire confidence of the public, unless the private paper it has discounted, be all, like its own notes, payable on demand; but, as it is no easy matter to find substantial assets, that shall bear interest, and at the same time be redeemable at sight, the next best course is to confine its issues to bills of very short dates; and, indeed, well-conducted banks have always rigidly adhered to this principle.


From the preceding considerations may be deduced a conclusion, fatal to abundance of systems and projects, viz. that credit-paper can supplant, and that but partially, nothing more than that portion of the national capital performing the functions of money, which circulates from hand to hand, as an agent for the facility of transfer; consequently, that no bank of circulation, or credit-paper of any denomination whatever, can supply to agricultural, manufacturing, or commercial enterprise, any funds for the construction of ships or machinery, for the digging of mines or canals, for the bringing of waste land into cultivation, or the commencement of long-winded speculations; any funds, in short, to be employed as vested capital. The indispensable requisite of credit-paper is, its instant convertibility into specie; when the sum total of the paper issued does not exist in the coffers of the bank, under the shape of specie, the deficit should at least be supplied by securities of very short dates; whereas, an establishment, that should lend its funds to be vested in enterprises, whence they could not be withdrawn at pleasure, could never be prepared with such securities. An example will illustrate this position. Suppose a bank of circulation to lend 6,000 dollars of its notes, circulating as cash, to a landholder on mortgage of his land, presenting the amplest security. This loan is destined by the landholder to the construction of necessary buildings, for the cultivation of the estate; for which purpose he contracts with a builder and pays him the 6,000 dollars of notes advanced by the bank. Now, if the builder, after a short lapse of time, be desirous of turning the notes into specie, the bank can not pay him by a transfer of the mortgage. The only property the bank has to meet the 6,000 dollars of notes is a security, ample beyond doubt, but not available at the moment.


The securities in the hands of a bank, I hold to be a solid basis for the whole of its issues of notes, provided those securities be of solvent persons, and have not too long to run; for the securities will be redeemed either with specie, or with the notes of the bank itself. In the first case, the bank is supplied with the means of paying its notes; in the second, it is saved the trouble of providing for them.


If, by any circumstance, the notes be deprived of their power of circulating as specie, the task of replacing the metal for the paper-money does not devolve upon the bank; nor was it at the first saddled with the business of turning to account the metal-money its notes rendered superfluous. For, as we have already observed, the bank can extinguish the whole of its paper with the private securities it holds. The inconvenience falls upon the public, which is under the necessity of finding a new agent of circulation, either by a re-import of the metal-money, or by the substitution of private paper; but probably the public would, in such circumstances, apply again to a bank conducted on sound principles.*94


This will serve to explain, why so many schemes of agricultural banks for the issue of circulating and convertible notes on ample landed security, and so many other schemes of a similar nature, have fallen to the ground in very little time, with more or less loss to the shareholders and the public.*95 Specie is equivalent to paper of perfect solidity, and payable at the moment; consequently it can only be supplanted by notes of unquestionable credit, and payable on demand; and such notes cannot be discharged by a bare security, even of the best possible kind.


For the same reason, bills of exchange in the nature of accommodation-paper, as it is called, can never be a sound basis for an issue of convertible paper. Such bills of exchange are paid when due by fresh bills, that have a further term to run, and are negotiated with the deduction of discount. When the latter fall due, they are met by a third set payable at a still later date, which are discounted in like manner. If the bank discounts such bills, the operation is no more than an expedient for borrowing of the bank in perpetuity; the first loan being paid with a second, the second with the third, and so on. And the bank experiences the evil of issuing more of its notes, than the circulation will naturally absorb, and the credit of the establishment will support; for the notes, borrowed upon such bills, do not help to circulate and diffuse real value, because they represent and contain no real value themselves; consequently, they continually recur to be exchanged for specie. It is on this account, that the discount-bank of Paris, while it continued to be well administered, did, as the present banks of France and England do still refuse, as far as it is able, to discount accommodation-paper.


The consequences are similar and equally mischievous, when a bank makes advances to government in perpetuity, or even for a very long period.*96 This was the cause of the failure of the bank of England. Not being able to obtain payment from government, it was unable to withdraw the notes in which the loan was made. From that moment its notes ceased to be convertible; and until the resumption of cash payments in 1822, enjoyed a forced circulation. The government, being itself unable to supply the bank with the means of payment, discharged that body from its liability to its own creditors.*97


The holders of the notes of a bank issuing convertible money run little or no risk, so long as the bank is well administered, and independent of the government. Supposing a total failure of confidence to bring all its notes upon it at once for payment, the worst that can happen to the holders is, to be paid in good bills of exchange at short dates, with the benefit of discount; that is to say, to be paid with the same bills of exchange, whereon the bank has issued its notes. If the bank have a capital of its own, there is so much additional security; but, under a government subject to no control, or to nominal control only, neither the capital of the bank, nor the assets in its hands, offer any solid security whatever. The will of an arbitrary prince is all the holders have to depend upon: and every act of credit is an act of imprudence.


As far as I am capable of judging, such is the effect of banks of circulation and of their paper issues upon individuals and national wealth. This effect is described by Smith in a quaint and ingenious metaphor. The capital of a nation he likens to an extensive tract of country, whereupon the cultivated districts represent the productive capital, and the high roads the agent of circulation, that is to say, the money, that serves as the medium to distribute the produce among the several branches of society. He then supposes a machine to be invented, for transporting the produce of the land through the air; that machine would be the exact parallel of credit-paper. Thenceforward the high roads might be devoted to cultivation. 'The commerce and industry of the country, however,' he continues, 'though they may be somewhat augmented, cannot be altogether so secure, when they are thus, as it were, suspended upon the Dædalian wings of paper-money, as when they travel about upon the solid ground of gold and silver. Over and above the accidents, to which they are exposed from the unskilfulness of the conductors of this paper-money, they are liable to several others, from which no prudence or skill of those conductors can guard them. An unsuccessful war, for example, in which the enemy get possession of the capital, and consequently of that treasure, which supported the credit of the paper-money, would occasion a much greater confusion in a country, where the whole circulation was carried on by paper, than in one, where the greater part of it was carried on by gold and silver. The usual instrument of commerce having lost its value, no exchanges could be made except by barter or upon credit. All taxes having usually been paid in paper-money, the prince would not have wherewithal either to pay his troops, or to furnish his magazines; and the state of the country would be much more irretrievable, than if the greater part of its circulation had consisted in gold and silver. A prince, anxious to maintain his dominions at all times in the state in which he can most easily defend them, ought upon this account to guard, not only against that excessive multiplication of paper-money, which ruins the very banks which issue it, but even against that multiplication of it, which enables them to fill the greater part of the circulation of the country with it.'*98


Forgery alone is enough to derange the affairs of the best conducted and most solid bank. And forgery of notes is more to be apprehended, than counterfeits of specie. The stimulus of gain is greater. For there is more profit to be made by converting a sheet of paper into money, than by giving the appearance of precious metal to another metal, that has some though very little, intrinsic value, especially if it be compounded or covered with a small portion of the counterfeited metal; and perhaps, too, the materials for the former operation are less liable to discovery. Besides, the counterfeits of specie can never reduce the value of the specie itself, because the latter has an intrinsic and independent value as a commodity; whereas, the mere belief that there are forged notes abroad, so well executed, as to be scarcely distinguishable from the genuine, is enough to bring both forged and genuine into discredit. For which reason, banks have sometimes preferred the loss of paying notes they know to be forged, to the hazard of bringing the genuine ones into discredit, by the exposure of the fraud.


One method of checking the immoderate use of notes is, to limit them to a fixed and high denomination of value; so as to make them adapted to the circulation of goods from one merchant to another, but inconvenient for the circulation between the merchant and the consumer. It has been questioned whether a government has any right to prohibit the issue of small notes, where the public is willing to take them; and whether such limitation be not a violation of that liberty of commerce, which it is the chief duty of a government to protect. But the right undoubtedly is just as complete, as that of ordering a building to be pulled down, because it endangers the public safety.

Of Paper-Money.


The distinctive appellation of paper-money, I have reserved exclusively for those obligations, to which the ruling power may give a compulsory circulation in payment for all purchases, and discharge all debts and contracts, stipulating a delivery of money. I call them obligations, because, though the authority that issues, is not bound to redeem them, at least not immediately, yet they commonly express a promise of redemption at sight, which is absolutely nugatory; or of redemption at a date expressed, for which there is no sort of security; or of territorial indemnity, the value of which we shall presently inquire into.


Such obligations, whether subscribed by the government or by individuals, can be converted into paper-money by the public authority only, which alone can authorise the owners of money to pay in paper. The act is, indeed, an exertion, not of legitimate, but of arbitrary authority; being a deterioration of the national money in the extreme degree.


Upon the principles above established, it should seem, that a money destitute of all value as a commodity, ought to pass for none in all free dealing subsequent to its issue; and this is always the case in practice sooner or later. The notes of what was improperly called Law's Bank, and the assignats issued during the French revolution, were never regularly called in or cancelled; yet those of the highest denomination would not pass at present for a single sol. How then, came they ever to pass for more than their real value? Because there are many expedients of fraud and violence, which will always have a temporary efficacy.


In the first place, a paper, wherewith debts can be legally, though fraudulently, discharged, derives a kind of value from that single circumstance. Moreover, the paper-money may be made efficient to discharge the perpetually recurring claims of public taxation. Sometimes a tariff or maximum of price is established; which, indeed, soon extinguishes the production of the commodities affected by it, but gives to the paper-money a portion of the value of those actually in existence. Besides, the very creation of a paper-money with forced circulation occasions the disappearance of metallic money; for, as it is made to pass at par with paper, it naturally seeks a market, where it can find its true level of value. The paper-money is thus left in the exclusive possession of the business of circulation; and the absolute necessity of some agent of transfer, in every civilized community, will then operate to maintain its value.*99 So urgent is this necessity, that the paper-money of England, consisting of the notes of the bank, has been kept at par with specie, simply by the limitation of the issues to the demands of circulation.


Nations precipitated into foreign wars, before they have had time previously to accumulate the requisite capital for carrying them on, and destitute of sufficient credit to borrow of their neighbours, have almost always had recourse to paper-money, or some similar expedient. The Dutch, in their struggle with the Spanish crown for independence, issued money of paper, of leather, and of many other materials. The United States of America, under similar circumstances, likewise had recourse to paper-money; and the expedient that enabled the French republic to foil the formidable attack of the first coalition, has immortalized the name of assignats.


Law has been unjustly charged with the whole blame of the calamities resulting from the scheme that bears his name. That he entertained just ideas respecting money, may be gathered from the perusal of a tract*100 he published in his native country, Scotland, to induce the Scotch government to establish a bank of circulation. The bank established in France, in 1716, was founded on the principles there set forth. Its notes were expressed in these words:


"The bank promises to pay the bearer at sight ******* livres in money of the same weight and standard as the money of this day. Value received at Paris," &c.


The bank, which was then but a private association, paid its notes regularly on demand: they were not yet metamorphosed into paper-money. Matters remained on this footing, and went on very well, till the year 1719;*101 at which period the king, or rather the regent, repaid the shareholders, and took the management into his own hands, calling it the Royal Bank. The notes were then altered to this form:


"The bank promises to pay the bearer at sight ******* livres in silver coin. Value received at Paris," &c.


This alteration, slight as it was in appearance, was a radical one in substance. The first note stipulated to pay a fixed quantity of silver, viz. the quantity contained in the livres current at the date of issuing the notes. The second merely engaged to pay livres, and so opened a door for whatever alterations an arbitrary power might think proper to make in the real value expressed by the word livre. And this was called fixing the rate of the paper-money; whereas, on the contrary, it was unfixing, and making it a fluctuating value; and the fluctuations were truly deplorable. Law strenuously opposed the innovation; but principle was compelled to give way to power; and the crimes of power, when the consequences began to be felt, were confidently attributed to the fallacy of the principle.


The assignats issued by the revolutionary government were worth even less than the paper-money of the regency. The latter gave a promise, at least, of paying in silver: and, though the payment might be greatly curtailed by a deterioration of the silver coin, yet sooner or later the paper might have been redeemed, if the government had but been more moderate in its issues, and more scrupulous in fulfilling its engagements. But the assignats conveyed no right to call for silver; nothing but a right to purchase or obtain the national domains. Let us see what this right was really worth.


The original assignats purported to be payable at sight, at the Caisse de l'Extraordinaire, where they were, in fact, never paid at all. It is true, they were received in payment for the national domains bought by individuals at a competition-price; but the value of these domains could never give any determinate value to the assignats, because their nominal value increased exactly in proportion as that of the assignats declined. The government was not sorry to find the price of national domains advance, because it was thereby enabled to withdraw a greater amount of assignats, and consequently, to re-issue new ones, without enlarging the quantity afloat. It was not aware, that, instead of the national domains advancing in price, the assignats were undergoing a rapid depreciation, and that the further that depreciation was pushed, the more assignats must be issued in payment of an equal quantity of supplies.


The last assignats no longer purported to be payable at sight. The alteration was little attended to, because neither first nor last were, in fact, ever paid at all. But their vicious origin was made more apparent. The paper contained these words:


"National domains—Assignat of one hundred francs," &c. Now, what was the meaning of the term one hundred francs? What value did they convey the notion of? Was it the value of the quantity of silver, heretofore known under the designation of one hundred francs? No; for 100 fr. could not possibly be obtained with an assignat to that amount. Did it convey the idea of as much land, as might be purchased for 100 fr. in silver? Certainly not; for that quantity of land could no more be obtained, even from the government, by an assignat of 100 fr. than 100 fr. in specie. The domains were disposed of at public auction for as many assignats as they would fetch; and the value of this paper had latterly so far declined, that one of 100 fr. would not buy an inch square of land.


In short, setting aside all consideration of the discredit attached to that government, the sum expressed in an assignat presented the idea of no definite value whatever; and those securities could not but have fallen to nothing, even had the government inspired all the confidence, of which it was so eminently destitute. The error was discovered in the end, when it was impossible any longer to purchase the most trifling article with any sum of assignats, whatever might be its amount. The next measure was to issue mandats, that is to say, papers purporting to be an order for the absolute transfer of the specific portion of the national domains expressed in the mandat: but, besides that it was then too late, the operation was infamously executed.

Notes for this chapter

If the credit on London be payable in paper-money instead of specie, the course of exchange with Paris of the pound sterling, may, perhaps, fall to 21 fr., 18 fr., or even less, in proportion to the discredit of the paper of England.
In that expense I include the charge and risk of transport and of smuggling also, if the export of specie be prohibited; which latter is proportionate to the difficulty of the operation. The risks are estimated in the rate of insurance.
This position applies to foreign commerce only; the monopoly-profits of individuals in the home-market are not entirely national gains. In internal dealings, the sum of the utility obtained is all that is acquired by the community.
Venice, Genoa, Amsterdam, and Hamburgh had each an establishment of this nature. All have been swept away by the torrent of the revolutionary war; but there may be some use in examining the nature of institutions that may some day or other be re-established. Besides, the investigation will throw light upon the history of the communities that established them, and of commerce in general. At any rate, it was necessary to enumerate all the various expedients that have been resorted to as substitutes for money.
Public banks of deposit are now quite obsolete, and will probably never be revived. In fact they are clumsy expedients, suited only to the early stages of commercial prosperity, and are liable to many inconveniences. They hold out a strong temptation to internal fraud and violence, as well as to external rapacity; they withdraw from active utility a large portion of the precious metals, which might perhaps be turned to better account elsewhere; and they yield a degree of facility of circulation nowise superior to what may be afforded by the common process of banking, except perhaps in security, and infinitely more expensive to the public and to individuals. They have accordingly been everywhere supplanted by banks of circulation, or by the expedient of an inconvertible paper-money. Translator.
The two methods resolve themselves practically into one; for merchants of good credit can always procure discountable paper; and the sole essential difference is, that, in one case, the credit is individual and unevidenced, in the other, evidenced, and, in most cases, joint also. The bank of England requires the names of more than one firm on the paper it discounts. Country bankers often content themselves with the security, or note of hand, of the borrower alone. Translator.
No account is here taken of the money hoarded, which, for the national interest, might just as well have remained in the mine.
Wealth of Nations, book ii. c. 2.
Since the first publication of this passage, this very circumstance has happened in respect to the bank of Paris, in 1814 and 1815, when that capital was besieged and occupied by the allied armies. The advances of the bank to the government, and to individuals, which could not be recalled immediately, did not exceed the capital of the establishment, for which the shareholders can not be called upon; and its paper-issues, payable to bearer, were all covered, either by specie in hand, or by commercial paper of short dates. By this means, notwithstanding the very critical circumstances of the moment, the merchants continued to employ its notes: which they could not well do without; and they were paid as usual in cash without interruption, during the whole of the hostile occupation: which shows at once the utility of a bank of circulation, and the advantage of leaving inviolate the convertibility of paper-issues.
In 1803, the land-bank of Paris was, for this reason, obliged to suspend the payment of its notes in cash; and to give notice, that they would be paid off by instalments out of the proceeds of its real securities.
That is to say, advances its notes. A bank, like an individual, may advance its capital, which then becomes more or less vested and fixed. The whole capital of the bank of England has been thus advanced; and there would have been no danger, had it not advanced its notes also. When the advances of paper are made upon transferable securities, stock, exchequer bills, and the like, those securities may be sold for cash, or for the notes of the bank itself, so long as they retain their value, and thus the safety and solvency of the bank maintained. But this operation is unnecessarily complex; for the government might itself have sold, and thus have saved the brokerage or profit accruing upon the operation to the bank. Translator.
Thornton, in his tract on the Paper Credit of Great Britain, written expressly with a view to justify the suspension of cash-payments by that establishment, has attacked the positions of Smith upon this subject. He tells us, that the extraordinary run upon the bank, which brought about the suspension, was occasioned, not by the excess of its issues, but, on the contrary, by their partial contraction. "An excessive limitation of bank-notes," he observes, "will produce failures, failures must cause consternation, and consternation must lead to a run upon the bank for guineas." By this reference to an extreme case, he endeavours to support his paradoxical opinions. When a convertible paper has succeeded in driving out of the country too large a portion of the metallic money, and the confidence in the paper happens suddenly to decline, great confusion and embarrassment will doubtless ensue, because the remaining agent of circulation is insufficient to effect the business; but it is a great mistake to suppose, that the deficiency can be remedied by the multiplication of a paper, not enjoying the confidence of the public. If the bank of England was able to survive the shock, it was because of the indispensable necessity of some agent of transfer, of some money or other, of paper in default of all others, in so commercial a country; because the government and the bankers of London, who were interested in the safety of the bank, unanimously agreed not to call upon it for cash, until it should be in a condition to pay; that is to say, until the government should have paid its advances in actual value. The bank had lent to the government more than its whole capital; for to that extent it might have gone with safety, its capital not being wanted for the discharge or convertibility of its paper; had it not so done, the short bills in its possession would have been sufficient for the extinction of its convertible paper.
Wealth of Nations, book ii. chap. 2.
Wherever a paper-money has been established, the difference between its value in the home market, where it has utility, and its value in foreign markets, where it has no utility, has afforded a fruitful field for speculation, that has enriched many adventurers. In 1811, 100 guineas in gold would purchase at Paris a bill of exchange on London, for 140l. sterling, payable in the paper which was the only currency of England. Yet the difference between gold and paper in the London market at the same period, was only 15 per cent. It was in this way, that the paper was of higher value in England than abroad. Accordingly, I find from returns with which I have been favoured, that gold in guineas or bullion was smuggled into the ports of Dunkirk and Gravelines alone, in the years 1810, 11, 12, and 13, to the amount of 33,875,090 dollars. There was a similar speculation in other commodities at large; but it was attended with more risk and difficulty; the import into France being very hazardous, although the export from England was encouraged in every possible way. Yet this traffic would soon have found its level, for it must have produced bills on England in such quantity, as to have brought the exchange to par at least, had not the continental subsidies of England furnished a continual supply of bills on London without any return.
This work was translated into French while Law continued in the office of Controller-General of France; and is entitled Considerations on Commerce and Money.
Vide Dutot. tom. ii. p. 200, for a detail of the beneficial effects of the institution, as originally conducted.

End of Notes

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